Apple: Margins to Take Focus in FYQ3, Say BMO, Avondale

By Tiernan Ray

As I mentioned earlier, today was a big day for prognostications about Apple‘s (AAPL) fiscal Q3 report, due out tomorrow afternoon, after the closing bell.

The average estimate of analysts for that quarter is $35.02 billion in revenue and $7.31 per share in profit. Gross margin is expected at about 36.6%. The company’s own forecast was for $33.5 billion to $35.5 billion, and gross margin in a range of 36% to 37%.

Avondale Partners‘s John Bright, who rates the shares Market Outperform, with a $600 price target, today writes that Apple should be able to turn in $34.78 billion and $7.44 per share, based on a projection of 26 million iPhone units and 17.9 million iPad units, and a gross margin of perhaps 36.2%.

He thinks the outlook for this quarter may come in at less than the $37.07 billion and $7.93 per share the Street is modeling, with his own estimate being $35.35 billion and $7.68, “given lack of new product launches and increasing competition in the smartphone and tablet markets,” though he’s more positive about the long-term story for the stock.

Last quarter’s key item will be gross margin, he writes:

Gross margins have steadily come down from their peak of ~47% in March 2012 due to product mix (iPad Mini, older model iPhones generate lower margins) and increased costs. We will look for commentary on both, for example the iPad Mini’s contribution to the iPad segment and potential discussion of vendor changes. We also expect questions around the fact that long-term contracts with carriers have seen some pushback (example: Russia). Should AAPL shift back towards an online/direct distribution model, the loss of carrier subsidies could impact margins.

That longer-term picture depends on Apple offering its own television set to rekindle growth, he thinks.

BMO Capital‘s Keith Bachman, who has a Market Perform rating, raised his price target to $480 from $450, predicting outperformance in the quarter, and that the shares will rise, with the forecast not being as bad as investors are expecting, noting, “investor sentiment is very negative, or cautious on the long-term prospects on AAPL”:

We believe that AAPL stock will move higher near term. We think Apple will beat consensus estimates for the June quarter in revenue, gross margin, and EPS. We think Apple will likely guide below consensus for the September quarter, but by a relatively smaller amount than in the past few quarters.

Bachman is modeling $36.2 billion in revenue and $7.98 per share in net profit, with revenue up slightly from a prior $36.1 billion, but his profit view now lower than his prior $8.02 estimate. He now models a slightly lower Mac count, at 3.96 million units, and a slightly lower iPod count, at 4.96 million units, and maintains a view for 29 million iPhone units sold and 16 million iPads.

For September, he sees a possible forecast of $37.2 billion and $8.23 per share. Even if the forecast from Apple ends up being just $36 billion, flat with the June quarter, “While consensus estimates may need to come down by around $2 billion, this is a smaller variance than the past few quarters’ guidance.”

Bachman, too, believes margins are a key part of last quarter’s story. He projects gross margin above Street expectations for the June quarter, at 38%, even though he thinks profit was crimped by a rise in the cost of DRAM and NAND parts. Most of the nearly 10 points of gross margin decline in the last year has been about the shift in mix of sales from iPhone to iPad, he opines:

Our conclusion is that about a 400 bp increase in iPads as a percentage of revenue, and an equal decline of iPhones as a percentage of revenue negatively impacts margins by just over 100 bp. Therefore, of the 990 bp decline in gross margins, we can explain 570 bp. The decline in gross margins is not as bad as it looks. We believe that the balance of the decline in gross margins, or 420 bp, has been driven by price and cost.

The stock’s performance over time will depend a lot on this margin question, he thinks, with profit perhaps declining further:

As importantly, we project gross margins to decline by another 250 bp from the March 2013 quarter through the end of FY15, though we expect gross margins to rise in the June 2013 quarter. We project only a modest impact from mix over our forecast period. Therefore, a key assumption in our forecast is that we project a further decline in gross margins of 230 bp over the next 10 quarters, including the launch of a new iPhone targeted at the mid-range market. We believe our assumptions are reasonable, and the accuracy of this assumption will largely determine the direction of AAPL shares, in our view.

On the plus side, Bachman raised his estimates for next fiscal year, after assuming a higher average selling price for the rumored low-cost iPhone. He offers a projection of an average price of $450, above his prior forecast of $375, without saying where that estimates comes from. Hence, Bachman raises his 2014 forecast to $180.14 billion, with a 37% gross profit margin, and EPS of $42.67, from a prior forecast of $179.79 billion, 36.7%, and $42.08.

Apple shares today closed up $1.36, or 0.3%, at $426.31.

Update: Owning to a mis-print in Bright’s note, the original version of this post contained an erroneous description of his estimates for Apple’s June quarter. He is projecting iPhone sales of 26 million units and iPad sales of 17.9 million units. My apologies for any confusion caused by the error.

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There are 5 comments

JULY 22, 2013 8:10 P.M.

Anonymous wrote:

Verizon earnings suggested that iPhone sales increased 45% from June 2012 in June 2013 quarter. iPad growth rate is around 40% and software services is around 30%. Even iPhone growth is 10%, AAPL's revenue will be around 39 billion dollars with 37.5% margin.

JULY 22, 2013 8:49 P.M.

Sam wrote:

"37.4 million iPhone units"

That does not seem right. Did you mean 27.4m?

JULY 22, 2013 9:05 P.M.

Tiernan Ray wrote:

Sam: Yes, there was a mis-print in Bright's report. His actual numbers are 26 million for iPhone and 17.9 million for iPad. My apologies and thank you for pointing out the error.

JULY 22, 2013 11:07 P.M.

Ira in LA wrote:

"Do you want me to cut your pizza into 8 slices or 16?"
"8, please. I'm not hungry enough to eat 16 slices."
vs.
"Would you like a small, medium, or large pizza?"

Who cares what the margins are if profit grows, share holds, and the ecosystem is sustained? What difference does it matter?

JULY 23, 2013 3:12 A.M.

ValleyOracle wrote:

I wonder, just wonder, what life would be like for everyone else if all the analysts are sent on a year long vacation to somewhere where they don't have any means to report. consumers buy what they like and reward companies that meet their needs. Companies should focus on innovating and producing/building good products and giving good customer service and should not be trying to meet or beat numbers set by the analyst camp.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.